Corporate Finance Manual

Accounting for corporate finance: foreign exchange: summary of differences between SSAP 20 and FRS 23, IFRS and New UK GAAP

Differences between SSAP 20 and FRS 23, IFRS and New UK GAAP

In many cases the requirements of all the accounting standards remain quite similar. Transactions in a foreign currency will continue to be translated at the spot rate for the appropriate day, while at the balance sheet dates, monetary items will be translated at the closing rate. Non-monetary items will still be translated at the historical exchange rate. Exchange differences arising on the translation of monetary items are taken to profit or loss.

The main differences between SSAP 20 under Old UK GAAP and the newer accounting standards are summarised in the table below:

SSAP 20 under Old UK GAAP

FRS 23, IFRS and New UK GAAP

Where a contract specifies an exchange rate at which a transaction is to be settled, the transaction must be settled at the contracted rate (CFM26070). Likewise, if a transaction is hedged by a forward contract, the transaction may be translated at the rate implied in the contract (CFM26080).

Use of the contracted rate is not permitted. The transaction must be translated at the spot rate for the day on which it takes place, unless hedge accounting techniques are used (see CFM21000).

Where a monetary item, such as a long-term loan, forms part of the company’s net investment in a foreign operation, exchange differences on translation can be taken to the Statement of Total Recognised Gains and Losses (STRGL).

In individual company accounts, such exchange differences in respect of loans to a subsidiary must go to profit and loss account. In consolidated accounts and for ‘loans’ to a branch, such differences go to reserves (to STRGL or as other comprehensive income).

Gains on long-term monetary items can be deferred if there are doubts about the convertibility of the currency.

No such deferral is permitted.

The ‘local currency’ of a company is defined as the currency of the primary economic environment in which the company operates and generates cash flows. It is assumed, although not spelt out, that the company will prepare its accounts in the local currency.

FRS 23, IFRS and New UK GAAP define a company’s ‘functional currency’ in similar terms - it is the currency of the primary economic environment in which the company operates. But a company’s ‘presentation currency’ - the currency in which it prepares its accounts - doesn’t have to be its functional currency. If the company prepares its accounts in a currency that isn’t its functional currency, FRS 23, IFRS and New UK GAAP stipulate how amounts must be translated into the presentation currency. All resulting exchange differences are taken to the reserves (to STRGL or as other comprehensive income).

When a company prepares accounts including the results of foreign operations, the closing rate/net investment method is normally used to translate the results of a foreign subsidiary, but the temporal method must be used if the subsidiary is effectively an extension of the parent company’s business (CFM26270).

No such formal distinction is made. But where the subsidiary is just an extension of the parent’s business, its functional currency should be that of the parent. So the normal concept of consolidation - treating the group as one entity - applies. The overall effect is the same as if the subsidiary used a different currency from the parent, and the temporal method of translation was used.

Where the closing rate/net investment method is used, the profit and loss account of the subsidiary can be translated at either the closing rate or an average rate (CFM26220)

There is no option for use of the closing rate. An average rate must be used. (Strictly, items of profit or loss should be translated at the rate applicable to the individual transaction, but an average can be used provided it gives a reasonable approximation.)

Silent

Goodwill and fair value adjustments are to be treated as assets and liabilities of the foreign operation and to be translated at the closing rate.